Stoneridge: The Supreme Court’s Ruling and Its Impact – Part 2: The Roots of Scheme Liability
The origins of scheme liability and Stoneridge Investment Partners, LLC v. Scientific Atlanta, Inc., No. 06-43, slip op. (Jan. 15, 2008) trace to 1994, when the Supreme Court decided Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994). There, the Court held that liability under Section 10(b) cannot be premised on a theory of aiding and abetting. The decision was based largely on a literal reading of the text of the statute and a record where the it was agreed there was no deception and the plaintiff based the claim solely on a theory of aiding and abetting. The Central Bank Court emphasized the fact that anyone can be liable under Section 10(b) if each element of a private cause of action is established:
The absence of Section 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the Securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met … in any complex securities fraud, moreover, there are likely to be multiple violators. …
Id. at 191 (emphasis original).
The decision touched off a debate about who could be held liable under Section 10(b) as primary violator and a debate over how to draw the line between primary and secondary liability. This was a critical issue following Central Bank, not only in private damage cases, but also in SEC enforcement actions. Since the Court based its decision on the text of the statute and not one of the court crafted elements of the implied Section 10(b) private right of action, the ruling applied to both private damage cases and SEC enforcement actions.
The year after the Court’s Central Bank decision, Congress took up the issue in the context of considering what became the Private Securities Reform Act of 1995 (“PSLRA”). That Act placed procedural and substantive limitation on private securities damage actions based on repeated testimony about abusive actions, frivolous suits and huge settlements all out of proportion to the merits of the case. The SEC urged Congress to restore aiding and abetting liability for its actions, as well as in private damage cases. In passing the PSLRA, however, Congress chose only to add Section 20(e) to the Exchange Act, which gave the SEC the right to bring actions based on aiding and abetting. Congress did not extend the same right to private damage actions.
The decision by Congress when enacting the PSLRA set the stage for a years long struggle in the courts over the dividing line between primary and secondary liability. That debate spawned the theory of “scheme liability” to define who might be held liable in a Section 10(b) private damage action. Although this issue did not impact SEC enforcement actions in the wake of Section 20(e), the Commission crafted the theory of scheme liability in amicus briefs filed in some of the largest securities class actions which arose out of corporate debacles such as Enron (Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007) and Homestore (Simpson v. AOL Time Warner, Inc., 452 F.3d 1040 (9th Cir. 2006)) (both discussed here). This is consistent with the SEC’s long-held view that private securities damage actions are necessary adjunct to its enforcement program.
Next: The evolution of primary and secondary liability and the rise of scheme liability.